Daily Newsletter, Tuesday, 4/2/2019

Table of Contents

Market Wrap

Consolidation in Progress

by Jim Brown

After a 530-point Dow move over the prior two days, the market rested.

Market Statistics

I am pretty sure everyone reading these comments would gladly accept a 79-point decline after a 530-point gain. This is simple market consolidation and nothing to worry about. The indexes traded at major resistance and it held. There is no damage done and we are at a level that could provide a launching point to a higher level later in the week. Headlines will be the key.

The Nasdaq had a much different day than the Dow with only a couple short forays into negative territory. The tech stocks were led Google, Facebook and Apple and the index closed right on resistance at 7,850. Other than those four stocks the gains were minimal but so were the losses so the index managed to post an overall gain.

The economics for the day were lackluster with the March ISM for New York rising slightly from 61.1 to 66.9. While the rebound was minimal it was the first monthly gain in seven months since the ISM peaked at 76.5 in August. That was the longest decline in the 25 years the report has been produced. Unfortunately, the six-month outlook fell sharply from 71.5 to 53 and the lowest level in nearly ten years. Since May 2009. Analysts said the Amazon withdrawal from the New York project probably impacted the outlook.

The quantity of purchase index fell from 65.4 to 61.1 indicating a slowdown in the amount of goods purchased in single orders. The employment component declined slightly from 60.7 to 59.5. This report was only slightly positive despite the Fed's change in policy to lower for longer, which should benefit businesses in the city.

Durable goods orders for February declined -1.6% and slightly better than the -1.8% analysts expected. Unfortunately, January was revised lower from +0.4% to +0.1%. This was the first monthly decline in four months. Nondefense capital goods declined -6.3% and produced most of the drag on the headline number. Ex aircraft that number improved to -0.1%. Inventories rose 0.3% and the sixth monthly gain. The report was ignored by the market.

March auto sales came in much stronger than expected at 17.4 million annualized units compared to estimates for 16.8 million. This was up from the 16.6 million in February. Light trucks and SUVs continue to see the most demand. Higher fuel prices this summer could slow this surge in buying.

After the bell the weekly API inventories showed a gain of 3.0 million barrels of oil. Gasoline inventories declined -2.6 million barrels and distillates declined -1.9 million barrels. As I have been reporting, the decline in refined products is due to refiners depleting stocks of winter blend fuels ahead of the production of summer blend fuels. Some states require summer blend fuels starting April 1st while others adhere to Federal law for the switch by June 1st. In the fall, refiners must make the switch back to winter blends by September 15th.

Crude prices have spiked this week to $62.50 after several weeks of declines in active rigs in the USA. In a report released by the EIA on March 29th, there was a surprise decline in US production of 90,000 bpd between December and January. The prior month showed only an increase of 35,000 bpd, which was the weakest increase in months. Halliburton and Schlumberger both expect producers to cut spending by 10% in 2019 because of a drop in production in closely drilled wells. The relatively new practice of drilling multiple wells from the same location has led to a rapid decline in production from all the wells in the same cluster. They were originally thought to have very little cross level communication, but history is proving that communication between ranges is more common than expected.

The closer we get to Memorial Day the more likely oil inventories will decline as refiners ramp back up from the current 86.6% utilization to the normal 96% utilization during the peak season. The combination of rapidly falling production in Venezuela, problems in the Houston ship channel and uptick in refining should lift oil prices well over $65.

The forecast for Q1 GDP has taken a sharp turn higher. The Atlanta Fed real time GDPNow forecast has risen from 0.3% to 2.1% growth over just the last three weeks. We had several economic reports come in better than expected. The durable goods orders this morning was one of those reports. Inventory levels in that report have a big impact on GDP.

Wednesday begins the employment week with the ADP report. Estimates are hovering around 165,000 jobs with whisper numbers around 170,000. The ISM Nonmanufacturing Index is expected to show a minor one-point decline to 58.7. Since the services sector is 80% of the US economy, this is an important report.

The Nonfarm Payroll report on Friday is expected to rebound from the erroneous 20,000 number from February. The current estimate is around 175,000 new jobs. Weekly jobless claims were 211,000 last week and that level supports new hiring around 200,000 jobs per month. The country has about 150,000 people joining the workforce every month, so we need a number over 150,000 to keep the unemployment rate from rising.

We are wandering slowly through an earnings desert as we approach the beginning of Q1 earnings on April 15th when Citigroup, Goldman Sachs and Schwab kick off the week of financial earnings.

Earnings expectations for Q1 are now for a decline of -2.1% for earnings and +5.0% growth in revenue. Since forecasts at the beginning of the reporting cycle are typically low by as much as 4%, we could see Q1 end with positive earnings growth. That would be a longshot bet today but with the market moving higher some investors are making it.

Leading the earnings parade this morning was a disappointing report by Dow component Walgreens (WBA). The company reported earnings of $1.64 that missed estimates for $1.72. Revenue of $34.53 billion rose 4.6% but also missed estimates for $34.58 billion. In addition to missing estimates they cut revenue guidance to "roughly flat" from prior forecasts for 7% to 12% growth. On the plus side they boosted their cost savings target by 50% to $1.5 billion by fiscal 2022.

They said, "During the quarter, we saw significant reimbursement pressure, compounded by lower generic deflation, as well as continued consumer market challenges in the U.S. and U.K. While we had begun initiatives to address these trends, our response was not rapid enough given market conditions, resulting in a disappointing quarter that did not meet our expectations."

Multiple companies have already warned that Medicare reimbursement pressures would impact earnings in 2019. Given the size of Walgreens it should have been obvious they were going to see a serious impact. Shares fell 13% on the news and erased 44 Dow points.

Dave and Busters (PLAY) had a much better report. They earned 66 cents that beat estimates for 63 cents. Revenue of $331.8 million rose 8.8% and beat estimates for $324.5 million. That is a lot of tokens flowing through those games. Same store sales rose 2.9% and beat estimates for 2.2%. They guided for full year revenue of $1.37-$1.40 billion in revenue and bracketed estimates for $1.38 billion. They announced the addition of $200 million to their existing stock buyback program.

The company is moving to VR headsets for many of their arcade games and that puts them well ahead of their competitors. They launched VR games "DragonFrost" and Jurassic World VR Expedition last year and just released their VR game "Star Trek: Dark Remnant" in their leading-edge stores. Shares rose $3 to $53.53 in afterhours.

Gamestop (GME) reported earnings of $1.60 that matched estimates but was down from $2.02 in the year ago quarter. Revenue declined from $3.32 billion to $3.06 billion and missed estimates for $3.28 billion. Even worse they projected a 5% to 10% decline in revenue in 2019 and losses of up to 5 cents per share in Q1. The company is struggling to adapt to changes in the video game industry.

Microsoft has announced a new Xbox game console that only uses downloaded games. That prevents users from reselling the games to Gamestop on CDs as in the past. Apple and Google also announced new video game offerings that stream games through your browser and the game does not reside on your computer or mobile device. That means no CDs and no consoles needed to play the games. That means no resale opportunities for Gamestop. This is also going to impact the resale value of existing games and consoles. In addition to their woes, Activision Blizzard announced today they were going to release a battle-royale version of Call of Duty that would be free online in the month of April.

We were holding puts on GME in the Premier Investor newsletter and we held over earnings on expectations this would be an ugly report.

After the bell Qualcomm (QCOM) said its CFO George Davis had left the company to become CFO at Intel (INTC). He had been the CFO since 2013. Qualcomm said a longtime veteran of the company and treasurer would take over the duties while they search for a replacement. The parting was amicable. Shares fell about 25 cents in afterhours.

Troubled meal kit company Blue Apron (APRN) saw a 15% spike in afterhours when they announced that CEO Bradley Dickerson had resigned. He was replaced by the former CEO of Etsy, Linda Findley Kozlowski. She also held positions at Alibaba and Evernote. The company also said the Chief Technology officer, Ilia Papas was resigning effective May 3rd. Outgoing CEO Dickerson will receive 12 monthly payments of $41,666 and full vesting of his stock options. That is a sweetheart package for a company whose stock has fallen from $11 to $1 under his tenure.

Please list options on Lyft soon! I want to recommend puts! Lyft may have started off with a bang, but it is likely to end April with a whimper. The company is burning cash at the rate of nearly $1 billion a year. The only reason they have any material revenue is the heavy discounting they are doing in hopes of stealing market share from Uber. While it is a great service to use, the economics for the business are dismal.

When Uber comes public soon, it will be a killer for Lyft shares as people frustrated with the declines leave to invest in a much more diversified business. Lyft is going to be like Blue Apron. There has been a lot of hype but in the end the company must make money. The next several quarterly earnings reports are going to be painful. While they may eventually make money, it remains to be seen if they achieve that target before the stock reaches single digits. Because of their cash burn they will have to do some secondaries to raise more cash. Now that they are public, they are not going to have access to private capital. It will either be debt or stock offerings, which will further dilute the stock. Current investors and employees with stock in lockup are going to be watching the slow bleed in value and once that lockup expires they will be racing to the exits.

Stories were circulating all day about institutions looking for shares to short. Several large blocks did appear because the cost to borrow the shares was right at 100%. That means it would cost you about $10 a month to borrow the shares. That is very expensive.

Seaport Global Securities was the first broker to initiate coverage with a sell rating but there will probably be more. They are targeting $42 with their coverage. The analyst said it would take a "lofty leap of faith" to justify their valuation. Lyft produces $2.2 billion in revenue in 2018 and is targeting $5.5 billion in 2021 but has no real plan to get there. They are also projecting a 20% EBITDA margin but no real plan other than book more rides, charge more and pay drivers less. Competition is going to increase as other companies enter the space. Competition will reduce prices. It is going to be a tough year for Lyft. Please list options soon!

Markets

I am encouraged that the markets did not sell off after two big days of gains. Nobody expects the S&P to just race up to the prior high at 2,930 and come to a dead stop while we wait for the Chinese trade agreement. Talks are resuming in Washington this week but until somebody announces a visit to Mar-A-Lago resort, there is no deal.

Gains on Monday were powered by an unexpected uptick in China's economic reports, but that news has now faded. Headlines today have less than a 24-hour shelf life and the markets are constantly looking for some new catalyst for direction.

The Asian markets opened flat on Wednesday and without any change overnight they are likely to pause and consolidate while they wait on the Xi meeting. The Chinese market is up 27% for the year on expectations for trade so investors there are also worried about the extension in the negotiations.

In the US, the S&P touched the 2,872 level and resistance from January 2018 but was unable to move over it. This is critical resistance and could represent the potential for a head and shoulders top. While I do not expect it, the potential is always there.

As I have stated before, I do expect the markets to continue higher but feel we risk a sell a news event after any trade announcement. We also have the current Brexit date of April 12th for a hard exit without an economic deal. Prime Minister May said today she was going to ask again for another extension until May 22nd, but the EU turned her down last time. With time on the clock running out, she also agreed to meet with the opposition party to try and patch together some kind of deal that would be acceptable. Until that happens, April 12th could be significantly negative for the market.

The Dow surged through critical resistance at 26,191 on Monday but retraced that move and closed back below that level today. I am encouraged by the lack of a material decline. Only 9 Dow components were positive, but the index retained most of the gains from the prior two days. As expected, Boeing was a major contributor on Monday with a $10 gain that added about 70 Dow points. We cannot expect that every day. Boeing is nearing round number resistance at $400 and gains are likely to slow. Walgreens was a big detractor today but should be neutral tomorrow. Without a meltdown overseas tonight, we could see the Dow back in breakout territory on Wednesday.

The Nasdaq benefitted from a handful of big cap techs leading the charge. The rest of the stocks in the list below (22) moved less than $1 and basically spent the day consolidating their gains from Monday. To have the Nasdaq gain another 20 points after a 100-point gain on Monday is bullish. The index has moved up to the high from mid-March at 7,850 and that is current resistance.

The FANG stocks plus Apple were big supporters yesterday and today.

The small cap sector is not participating in the rally. We did see some gains on Monday, but they were less than the big cap indexes. The minor 3-point decline today when the Nasdaq was positive, is disappointing. I scanned about 65 small cap stocks and the recent winners are starting to roll over and the majority of the charts were bearish. We need to see the Russell find some traction and at least move through the 1,566 level and the 200-day at 1,576 in order to boost market sentiment. As long as the index languishes below these resistance levels the obvious direction is another dip lower. We need that surge to produce some short covering.

I am cautiously positive on the market as long as you understand it is short term only. Brexit, China negotiations, potential closing of the southern border and earnings warnings could flare up at any time. We are nearing the prior highs and with a weak earnings cycle ahead, I would not be surprised to see portfolio managers taking profits early rather than wait for the dip into the summer doldrums. May 1st would be a likely target for market weakness to appear, if not before.

Something happened at 8:30 ET as I was proofing this commentary. S&P futures spiked more than 10 points after being negative at 8:PM. I did not see anything on the wires, but somebody heard some news.

New Option Plays

Neutral Day

by Jim Brown

Tuesday was market neutral while we wait for Q1 earnings and trade news. Sometimes the market just needs a day or two to digest recent gains. That was today. After a 200-point rally on Friday and 329 points on Monday, this was a consolidation day. The lack of a material decline was positive and suggests we could move higher on the next catalyst.

New positions are only added on Wednesday and Saturday except in special circumstances. NEW DIRECTIONAL CALL PLAYS

No New Bullish Plays

NEW DIRECTIONAL PUT PLAYS

No New Bearish Plays

In Play Updates and Reviews

Resistance Testing

by Jim Brown

Tuesday was challenging with the major indexes struggling at resistance. Monday's rally had only very minor follow through and mostly on the Nasdaq. Critical resistance levels continued to maintain their gravitational pull on prices. The Dow could not close over 26,191 on two consecutive days. The S&P could not push over January 2018 resistance at 2,672. The Russell Only lost 3 points and that is actually a positive for market sentiment. We are likely to continue testing resistance until another catalyst appears to push us higher.

Current Portfolio

Stop Loss Updates

Check the graphic below for any new stop losses in bright yellow.
We need to always be prepared for an unexpected decline.

Profit Targets

Check the graphic below for any profit stops in green.
We need to always be prepared for a profit exit at resistance.

Current Position Changes

No Changes

Full updates on all plays on Wednesday and Saturday. Only closed plays are updated on other days.